An effective money management strategy requires a combination of traditional banking and investment solutions, and must be mindful of taxes.
Thorough liquidity planning addresses three categories of funding based on your needs: day-to-day operating capital, goals-based funding, and strategic positioning.
- Higher interest rates have increased the expected return on cash and equivalents. However, investors should consider after-tax profits when making money management decisions.
Ryan Fox: Hello everyone. Thank you for joining us today for a presentation on cash and liquidity options. We are pleased to have the opportunity to share information on how to determine the most valuable option for handling cash assets. We hope you find it useful enough to help you make timely decisions in the coming weeks and months.
So let’s get started. Let’s take a quick look at today’s topic. I would like to discuss four subject areas. By the end, we hope you have a solid understanding of what options you have for managing your financial assets. First, I would like to explain liquidity concentration. Here we explain how we think about cash and liquidity and how it can fit into the broader framework of financial planning.
Next, let’s look at banking solutions. Most people know about these, but I’d like to introduce a few that are less well known. After that, we will talk about investment solutions. There are many strategies that are lesser known but have become staples in many portfolios. Events earlier this year and the unique interest rate market we currently find ourselves in make investment solutions even more timely to discuss. Finally, let’s talk about prices. Here we detail our current rates and considerations that all clients should take into account when thinking about tax optimization.
So let’s start with liquidity considerations. The first category is daily operations. This is where you need to have high liquidity so you can access the funds you need for everyday necessities like mortgage payments, groceries, and gas. Therefore, liquidity is paramount here. The second is goal-based. These are funds you need for a specific purpose, such as a down payment on a home you will acquire in a few months or even years. Liquidity here is moderate.
The third one is strategic. In this case, liquidity may decrease slightly. Although these are not necessarily needed in the short term, they are still very important funds. For example, you can allocate funds to bonds in your portfolio to diversify your assets or provide a source of income. Historically, the lowest yields are found in the day-to-day operating categories, which carry the lowest risk, and the highest yields are found in the strategic categories, which carry the highest risk. I would like to point out that if you have more than $250,000 in your checking account for operating funds, you should reconsider whether you need that amount. And from a liquidity perspective, virtually everything I’m discussing today can be converted into cash in your checking account within a business day or two.
Next, we’ll discuss the pros and cons of various liquidity management solutions, but you’re probably familiar with many of these options, including bank accounts, certificates of deposit, and mutual funds. The important point here is that while they all have some advantages, they can also have disadvantages in some cases. Bank accounts are something most people have and tend to be a necessity, but they tend to have low yields and are generally not very tax efficient. Certificates of deposit and CDs, on the other hand, have historically had higher yields, but tend to come with penalties if you want to access the liquidity before maturity. Each of these solutions serves a purpose, and you can often implement multiple solutions to more effectively meet your financial needs.
Let’s move on to banking solutions. We’re all familiar with these, but here’s a quick overview of the three main types of bank accounts. Like traditional checking accounts, these savings accounts each come with $250,000 of FDIC coverage. NOW accounts offer higher yields but come with a potential penalty for early liquidity. Finally, Insured Cash Sweet (ICS) is a banking solution that allows one SVB account to seamlessly insure funds by depositing them at multiple institutions with an FDIC insurance coverage limit of $250,000. This allows for over $100 million in insurance coverage. This was a lesser-known option this year, but it’s important to point out that it’s also available to individuals.
In a little more detail, ICS is a convenient and easy way to protect your deposits. ICS allows you to deposit funds into multiple FDIC-protected accounts. Your funds will be transferred from your girlfriend’s SVB account to his deposit accounts at other ICS institutions and network banks in amounts below the standard FDIC insurance maximum of $250,000. This means that all deposits are still fully FDIC protected. You receive one statement that lists the placement of your funds across each institution, but otherwise works like a standard savings account. You get full access to all your funds, transaction history, and reports while working directly with one bank.
Now let’s move on to investment solutions. It is important to understand the context of today’s market. This chart looks at every Fed rate hike cycle going back to the early 1980s. The bottom of the graph shows how long each hiking cycle lasted, and the left side shows your speed increase. Simply put, the current rate hike cycle, shown in yellow, is the largest in terms of magnitude and the fastest pace we have ever experienced. This has significant implications and implications for how our clients should think about cash and other liquidity considerations and allocations.
This shows the yield curve at various points over the past few years. The gray line at the bottom of the chart is the position of the yield curve at the end of 2021. Despite being at historic lows, it was actually a normal yield curve. A normal yield curve means that it is upward sloping, meaning that investors receive the lowest yield with the shortest maturity and the highest yield with the longest maturity. Basically, it means that if you take on additional risk, you will get more reward.
The green line is where the yield curve will be at the end of 2022 after the Fed raises rates significantly. You can see that the yield curve is almost inverted. This means that those with longer maturities actually have lower interest rates than those with shorter maturities. In this environment, taking more risk means less reward. Now, if we fast forward to the end of last month, we can see the blue line where the current yield curve is located. The current yield curve is more or less completely inverted, with the highest interest rates seen at the shortest part of the curve. This also means that the longer the maturity, the lower the interest rate. The rolling treasury strategies we manage for our clients aim to allocate to the shortest maturity. There’s a good reason why this strategy has become so popular. Government bonds are widely regarded as the safest securities in existence, and investors can now earn superior returns with little risk.
Very short-term bond strategies can be used to increase income or reduce interest rate risk. This is another consideration for clients. These are typically obtained by allocating unneeded cash to operational needs and have a duration of less than one year. He has two different types of super short strategies. One is tax-free. These are often local securities of the country, are somewhat tax efficient, and are usually found and allocated to taxable accounts. The other is taxable, but because it lacks the tax benefits of municipal securities, it is typically allocated to a retirement account or other tax-advantaged entity. Even though these strategies have short time horizons, if the yield curve is normal and upward sloping, you can actually choose additional income strategies.
As you move toward more core bond holdings, the income provided by municipal bonds is often free of federal and state taxes at the time of purchase if they are issued in the same state as your home state. Municipal bond markets tend to be allocated by state. Portfolios can also take duration into account to help manage interest rate risk. Generally, the lower your credit score, the higher the interest rate you will receive. You can also choose ladder strategies, active strategies, etc. Ladder strategies lend themselves to goal-based considerations, while active strategies allow managers to make decisions based on prospects and relative values between different securities.
So we’ve looked at three categories of liquidity needs and the wide range of solutions that exist for both banking and investing. Here are some interesting points about interest rates and taxes.
Therefore, this is the menu of yields available as of the end of September 2023. The interest rates shown here are those widely available on the market today and are not necessarily specific or specific to SVB. This information was also obtained as of the end of last month, but please understand that the situation is subject to change. Therefore, this is primarily of an educational nature. This list is ordered from highest yielding solutions to lowest yielding solutions based on total yield. The whole world runs on total numbers, and this is what clients see when considering what to do with their hard-earned cash.
What’s important to point out is that virtually all of these numbers are now significantly higher than they were a year ago, and much higher than they have been over the past 15 years or so. This is very important. Because we’ve all operated in a world where no one even thought seriously about taxes because historically the income generated here was so small that the tax implications were never an issue. That’s no longer the case.
Here we look at yields through an after-tax lens. The specific analysis we are considering applies federal income tax rates of up to 37% and California state income tax rates of up to 13.3%. Liquidity solutions are sorted from left to right by maximum after-tax yield. The dark blue bar is the amount you can actually keep, i.e. the yield before taxes. The two lighter shades of blue represent the taxes you pay. The darker of the two represents federal taxes, and the lighter color represents California state taxes. We can clearly see that municipal bonds and rolling treasury strategies offer the highest after-tax yields.
Perhaps the most surprising thing for many people is how much of the income from CDs goes to taxes. The same goes for government money market funds as well as high-yield savings accounts. Finally, and not surprisingly, traditional checking accounts have lower yields, meaning you’re paying for the safety you get with an insured cash sweep solution in the form of lower yields. The yellow line that appears with the amounts is for illustrative purposes only, but it shows how much annual after-tax income he could expect if he allocated $1 million to each solution, all things being equal. It shows.
This is a different version of the previous chart for people who live in states that don’t have state income taxes, such as Nevada, Texas, and Florida. Although the results are generally similar, there are additional considerations for very short-term municipal bonds, where the relative liquidity of the Treasury is a key feature, despite the relatively low after-tax yield. It is important to mention that the current pricing environment is likely to change and we plan to optimize customer allocation based on market evolution. It is also important to note that each client’s individual needs are different, and a degree of customization and an understanding of individual tax rates are paramount to finding the right set of solutions.
Thank you for listening. We hope this article was helpful and helped you decide the best way to handle your funds and plan for the future. Please contact me or your SVB Private Wealth Advisor to learn how to incorporate some of these solutions we have discussed into your portfolio. thank you.